Do you pay no tax if you lose money on a business or an investment? If so, why is that?

Question

Is it true that in a business or an investment, we only pay tax if we make a profit? That is, if we make only a loss, there is no tax?

Why is this so? Because from what I understand, the tax is paid to the government because we are using the resources (roads, public libraries etc) built on government money. And we need to pay money to maintain these resources.

Now the man that makes a loss used these resources as much as the man that made a gain. So why does only one of them pay tax? Is the reason purely humanitarian?

Answer 1

There is more than one kind of tax. It is a little confusing because in reality the tax revenues collected by the Government aren't earmarked to a particular usage based on where they came from, usually. Well, the Gov't often CLAIMS they do, but for all practical matters it all goes in a big bucket. So just because a business or individual isn't paying income taxes doesn't mean they aren't paying anything for the use of Government furnished infrastructure/services.

You are limiting the scope of your question to Income Taxes, which are taxes paid on profits to a business or individual. It makes perfect sense that you wouldn't pay a tax on something you didn't get.

However, you aren't considering taxes that ARE being paid even by a company that isn't profitable. For example consumption taxes, employment taxes, and other fees. That same company paid sales tax on all the supplies it purchased, and probably collected/paid sales taxes on anything it sold. To take one of your examples, it paid for its share of using the roads through Government imposed taxes on fuel.

Don't worry about the Government. They know how to get theirs. They might not pull it from your right pocket, but they will make sure to get it from the left.

Answer 2

The business may not have paid any direct tax towards profit.
However it would have paid tons of indirect tax like Sales tax / Service tax on the goods / services rendered.
The raw material that he has purchased from vendors [leading to demand] would have been taxed. The salary he has paid [hence employees paying personal tax]

So essentially even from a loss making venture, the Govt has received enough tax money.

Answer 3

Not charging taxes on a money losing investment or business is much more than humanitarian it is common sense. In general money that is used to invest has already been taxed as income or inheritance to the person making the investment so taxing that money again not just the profit would provide a disincentive for people to invest. Which would be bad for economic growth over the medium and long term.

As far as taxing a money losing businesses goes, most businesses don't make money in their couple of years and adding further tax burdens would be counter productive because it would provide a major hurdle for people wanting to start a business. Other have already mentioned that the money losing operation likely paid indirect taxes as well. Small businesses provide a majority of the economic growth and innovation.

So in short additional taxes on money losing investments and businesses would be both foolish and shortsighted.

Answer 4

You mean to tell me that everyone doesn't pay his/her fair share?! Please say it isn't so. :)

Therein lies the welfare state: Tax the rich more heavily to subsidize the poor, and hobble the rich's ability to do so on their own accord.

In any case, though, in the United States, if you make any money whatsoever, that usually counts as income, and can hence be taxed. Here's the IRS' definition of gross income. Pretty all-inclusive, isn't it?

Businesses are allowed to deduct expenses to count against their income, but if one has more expenses than income year after year, (a) this is the road to financial ruin, and (b) the IRS puts an end to the tax losses after enough years of failing to show a profit.

So, sure, if a businessperson doesn't have any income, then they're technically using the roads, etc., "for free," but unless the businessperson wants to live off the land and the kindness of strangers, he'd better turn a profit eventually. Then he'll be taxed.

Answer 5

The tax system in general, and income tax in particular, is used for several purposes at once. One of those purposes is to raise money to run the government. It isn't the only purpose of income tax, and income tax isn't the only source of money to run the government.

Try a thought experiment: let's say it costs $10,000 per person per year to run the government. (It might actually cost far more or far less, that's not the point.) A super simple tax system would just ask each person for $10,000. But such a system isn't fair. Some people don't even earn $10,000 so they are literally not able to pay that. Some people, who earn a lot, can easily afford to pay more. So a still-pretty simple approach asks each person to pay a particular percentage of their income, and the hope is that this will add up to enough to run the government. This still doesn't feel fair to everyone - 10% of your income is hard to find when you're spending it all on rent and food, and easy to find when you have way more than you "need". So many countries have what's called a "progressive" system of income tax where you pay no tax on the first X of your income, then a small percentage on the next Y, a larger percentage on the next Z and so on.

But you asked about business profit. Some places don't tax business profits at all - they just collect income taxes on people once the money reaches them as salary or dividends. Other places do. Just as a person who doesn't earn any income can't send the government money, a business that spent more on expenses than it brought in as revenue can't send the government money either. So the tax is on profit. That seems fairer to most people anyway.

Things then get even more complicated for both business and personal income taxes because the government uses the system to encourage certain behaviours and to help people facing hard times. If you want to encourage people to get training and move into higher paying jobs, you might make tuition tax deductible. Most countries give a tax deduction for each small child you have. This isn't because people with children use less of the services government provides, is it? Instead it's an acknowledgement that people with children generally have less money to spend. Or an encouragement to have children, or something. Tax motivations are complicated.

If you charged all businesses a flat tax regardless of whether they were making or losing money, people might be hesitant to start companies that lose money at first. There might be less entrepreneurship in that country. If instead you only tax profits, it feels fairer and more people are likely to join in. So that's what most governments do.

Is the imaginary business owner who is not turning a profit somehow getting a free ride? They are still paying tax. If they took any salary for themselves, there was personal income tax on that. Everything the company bought, it paid sales tax on. There may have been excise taxes and such in other things they bought. The economic activity of the business has been driving the wheel of the local economy and spinning off some taxes at various levels that whole time. Whether the business itself is chipping in some corporate income tax too may not end up being particularly relevant.

Example: a sole proprietor has revenue of $100,000 and spends $10,000 on supplies and such. If the salary to the owner is $89,000 the company has a $1000 profit which it pays tax on. If the salary to the owner is $91,000 the company has a $1000 loss and doesn't pay tax (and may be able to use the loss to reduce taxes in a future year.) So what? The owner is paying personal income tax on roughly $90,000. The government is getting the support it needs.

Yes, some owners do all the "encouraged" things so that some income is not taxed either in the business or the personal sphere. That is presumably what the government wanted when it set those things up as deductions. Making charitable contributions, hiring new employees, building new facilities ... essentially the government is paying the business to do those things because they're good for the country. The overall government budget (funded by personal and corporate income tax along with sales tax, excises taxes etc) is supposed to achieve certain goals which include roads and schools but also job creation and the like. This is one of the ways they do that.

Answer 6

In the UK, I could start my own business - either as a self-employed person, or by starting a company. With a company, the company might have £50,000 income, £5,000 cost, and pay me a £45,000 salary. In that case the company has no profit and pays no taxes, but I personally pay income tax. Or I could pay myself any salary I like, say £20,000 salary, so I pay tax on £25,000 profit and £20,000 salary. The state actually gets less money in total if I set my salary so the company makes a profit.

If I'm self employed, income minus cost is my profit and I pay taxes on that. If I don't make profit, I pay no tax. Unfortunately, I also wouldn't have any money to buy food, pay the rent, and so on and so on. I'd have the same income and pay the same taxes as someone who is unemployed.

There are "businesses" that are just run for the enjoyment of the owner and don't make profit. Rich guy buys a farm and starts breeding race horses, that kind of thing. In that case, there is zero difference between a guy breeding race horses and calling it a "business" and another guy breeding race horses and calling it a hobby. Neither makes money and neither pays taxes.

Answer 7

Think about it from a more pragmatic POV -- on what basis would you levy taxes on money that is lost?

If your house were robbed, should you have to pay taxes based on the money stolen from you? What if your car breaks down?

Income in its simplest form is revenue - cost of goods sold. So if I buy a car for $10,000 and sell it to you for $8,000, I have negative income.